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Is the share market actually expensive?

The Australian share market, represented by the ALL ORDINARIES (Index: ^AXAO) (ASX: XAO) is not far off its multi-year high, however it is still well below the peak just before the GFC. Our largest businesses just haven’t performed strongly like blue chips in other countries, the Commonwealth Bank of Australia (ASX: CBA) share price is only up around 3% over the past five years.

Some of the reason for that non-recovery is dividends, if you look at the accumulation indexes we are some distance beyond the GFC high.

Another reason is that several large Australian businesses have been taken over, removing them from the index.

However, when you look at the American share market, which is representative of the world due to the global nature of those businesses, it is far beyond its GFC high.

However, just because something has done well doesn’t necessarily mean it’s expensive. It could go up and be cheap, or go down and actually be expensive.

One of the ways we look to measure the value of shares, of all market cap sizes, is the price/earnings ratio. What multiple is a business trading to its earnings?

You can use a p/e ratio for an individual share or the whole market. The iShares S&P 500 ETF’s (ASX: IVV) p/e ratio looks expensive historically and the CAPE ratio looks even worse.

However, you have to consider that the index has completely changed compared to the 1960s or earlier. Back then the index was made up of utility companies, railroad businesses and so on. These were slow-growing, capital-intensive businesses. Of course they would have low p/e ratios.

These days the biggest companies are technology businesses. They are capital-light and are growing at a fast pace. Indeed, Facebook and Alphabet (Google) are still both increasing revenue at more than 20% per year.

Foolish takeaway

If you take into account the growth of the biggest constituents and the strengthening USA economy (plus Trump’s tax cuts) then the share market doesn’t look too bad at all.

But it’s definitely not cheap either. I wouldn’t be selling the house to buy shares any time soon.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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